 Keynesian Economics Works
- Sometimes!
Howard Ruff
The Ruff Times
Jan 9, 2009
Washington has plunged full
bore into Keynesian economics, based on the principle that government
can increase spending to alleviate economic downturns, while
ignoring the fact that Keynes said that we should decrease government
spending to cool the economy.
The government is creating
money and spending it or giving it away at a rate unprecedented
in my long lifetime. But the problem is that the end result is
not anticipated.
Let me tell you what I think
will happen in 2009:
First, we will continue to plunge into a major deflation
period which will be characterized as a "recession,"
and later in the year as a "depression." Deflation
and inflation are always monetary phenomena.
Second, deflation will evolve into a run-away-hyper-inflationary
depression because of what government will do to try to prevent
deflation, which is synonymous with depression and has overtones
of the 1930s.
The government is creating
money at a rate unprecedented in all of American History, with
deflation and depression, driving their decisions, as politicians
hate deflation. That is why they have been inflating the currency
at varying rates for decades.
Now the Treasury and the Federal
Reserve are pouring money into the economy at an unprecedented
rate. Inflation is a monetary phenomenon caused by creating too
much currency, and we are doing this like crazy.
But another factor is not very
well understood, and that is that creating money isn't necessarily
inflationary at the moment of creation, because the money that
has just been created is just sitting there. The banks have gotten
the bailouts that improved their balance sheets and preserved
their survival. But the money just sits there. The velocity of
money is what really counts.
A dollar changing hands and
paying for economic activity through the loan process at a high
rate is inflationary. A dollar just sitting there is not. The
banks have repaired their balance sheets and are just sitting
on their cash.
Until they start lending again
and people begin to put the money to work, it will not be inflationary.
When the banks start lending money again and people start using
it, and the velocity of money increases, then it will
be inflationary. So this final element must eventually materialize.
Based on Keynesian economics,
the government is suggesting "a little bit of hair of the
dog that bit us," which is an old English expression that
says if you have a hangover, a little more liquor will help.
Actually it only makes alcoholism worse.
Debt got us into this mess;
people borrowing money they couldn't afford to buy houses they
couldn't afford; credit-card debt is growing like crazy. People
are borrowing to go to college who should perhaps be in a trade
school, but they accumulate debt before they drop out. Consumers
were borrowing against their houses in the bubble so they could
buy more things.
In the meantime, we old stick-in-the-muds
who refrain from debt have reduced our spending to less than
we could earn. Debt caused the problem, and now the government
is suggesting that their effort to create literally trillions
of dollars is designed to give us more money to borrow and encourage
us to spend it.
I remember on 9/11 when President
Bush announced that "we should continue to borrow and spend
or the terrorists have won." Although he did most everything
else right as far as terrorism is concerned, that was sheer madness.
Keynesian economics says "create
the money, let people borrow it and spend. Consumer spending
will trigger an active economy." That's true when you're
fighting deflation and recession. But the government, as usual,
is engaging in overkill, and the amounts of money they are creating
will not be just sitting there lifeless forever. Eventually the
banks will lend, because if they don't lend, they don't make
any money, and bankers are in the business of making money. So
they can't sit on their money forever out of fear. Fear will
fade, and bankers will get back to their real business. When
that happens, we are headed for the classic hyper-inflation.
I expect as much as a year
of deflation while the government continues to pump money into
the banks and tries to encourage them to loan it into circulation
because that is the way government gets the money into people's
hands and gets them spending.
Our whole sick economy is based
on borrowing and spending. I'm sorry, I won't do that, and I
won't recommend that my subscribers do that.
"But," I hear you
say, "If everyone just stopped borrowing and buying and
just saved their money, it would create a depression."
That's probably true, but everyone
won't do it. My subscribers, as numerous as they are, are a very
small percentage of the population. So they will control their
spending, reduce their debt, and prepare for the next opportunity.
That opportunity will be inflation. Inflation will create opportunity
for the savvy saver and investor.
In the Meantime:
Invest for Deflation?
I'm in untrodden territory.
I know exactly how to invest in inflation. I've been planning
for inflation, off and on, for almost 32 years.
But now this is a deflationary
period, which will soon bloom into a runaway inflation. So how
should you invest in the interim?
Inflation and deflation are
monetary phenomena. Inflation is caused by increasing the supply
of fiat currency, and consumer prices respond to the dilution
of the currency.
But what should you do now
when you are faced with the opposite - deflation? Deflation means
that either the amount of currency has shrunk, or as in the present,
the velocity of money is down, with banks sitting on money without
putting it into circulation. That is about the same as reducing
the money supply.
While the government is now
trying to inflate the currency to fight deflation, we are fighting
the financial consequences of falling prices. So what should
you do with your money?
During deflation, prices will
inevitably fall. That means the value of currency will increase.
Whereas with inflation the last thing you want is an inflating
currency steadily losing value, with deflation, the exact opposite
is true.
One of your best investments
for a little while will be cash. The first thing you can do is
get out of debt and put your money short-term into dollar-denominated
investments, because this deflation will be a short-term phenomenon.
Where is a safe place for your
money? I suggest a money-market fund or a savings and loan, as
they are less damaged than the commercial banks and the banking
system. Keep a close eye on it because this deflationary period
is transitory. We know it will morph into inflation once money
starts circulating in the economy. Your most profitable bet might
be to buy inflation hedges now while they are cheap and wait
patiently, perhaps as much as a year. At the very least you would
be in cash, getting ready.
Moving Metals
The traditional inflation hedge
has always been precious metals. They have been moving recently.
Silver, which has been as low as $9.20 per ounce, is
now around $11.40 and will go much higher in anticipation of
the coming inflation.
Perhaps the safest way to invest
in gold and silver now, with the real shortage of bullion and
a wait as long as three months to get your metal from the dealer,
is to invest in the Central Fund of Canada, Ltd. (CEF)
listed on the American Stock Exchange. When you buy shares of
CEF, unlike most mutual funds, they don't buy stock, they buy
gold and silver bullion - one ounce of gold for every 50 ounces
of silver.
I have been following them
closely; they have been buying the appropriate bullion. That
way you will be covered by both gold and silver.
When everything else in the
world was crashing (stocks, real estate, etc.), gold held up
pretty well. It is down maybe five or six percent when the stock
market is down 40 or 50 percent.
Silver is due for an explosive
up-move. If you have some, hang onto it. Any additional money
should be put it into CEF.
The current deflation with
falling gas prices and falling prices at the supermarket is a
transitory event. Consistent with my strategy to make long-term
calls, you can invest for the future. This means inflation hedges.
Concentrate on CEF.
If you have $10,000 lying around,
I would keep at least $4,000 in cash. I would pay off all my
debts as fast as possible, leaving your cash available to be
moved into inflation hedges when inflation is reborn.
That is the best strategy for
this transitory period, while planning for the future boom in
inflation hedges.
###
Howard Ruff
email: corporate@rufftimes.com
website: www.rufftimes.com
Howard J.
Ruff,
the legendary author and financial advisor, has re-edited and
re-issued his 1978 mega bestseller, How to Prosper During the
Coming Bad Years, still the biggest-selling financial book
in history, with 2.6 million copies in print. He is founder and
editor of The Ruff Times financial newsletter. This article
is from The Ruff Times. The newsletter is much more comprehensive
and deals with a broad spectrum of middle-class financial issues
and includes an Investment Menu from which you can build your
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During the Coming Bad Years in the 21st Century, is in book
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